Have you ever dreamed about packing in the J.O.B. way before pension age?
The thought has probably crossed your mind – like, every Monday morning.
What stops most people from acting out that fantasy is a lack of winning lottery numbers. But in all seriousness, how much do you actually need to retire?
£10 million? £5 million? Could you do it on £1 million at a push?
You might be surprised to know that early retirement in the U.K. could be achieved on much less. Let’s crunch the numbers and work out how much you actually need to never have to work again.
Designing Your Retired Lifestyle
The first step in retirement planning – whether you’re planning for a traditional retirement or planning to escape the rate race in your 30’s – is to decide what kind of lifestyle you would like.
This is the exciting part where you get to design a life where you act out all those someday fantasies, so have some fun with it.
Start by thinking about the big picture stuff.
- What does your dream lifestyle look like?
- How do you want to feel every day? Less stressed? Carefree? Or do you want to still feel productive?
- Do you want your days to be planned or spontaneous?
- Do you want to have more fun?
- What things and experiences would make you happy?
Next, it’s time to drill down and go deeper on the day-to-day details:
- What activities do you want to do each day?
- Do you want to work at all?
- How often do you eat out?
- Where do you shop?
- Do you go on holiday every year? Where to? How many times?
- What hobbies do you do?
When envisioning your retirement, bear in mind that the more extravagant your lifestyle, the more money you’ll have to save.
This graphic from the Daily Mail shows the kind of lifestyle afforded in traditional retirement for annual incomes of £10k, £20k and £30k.
When designing your own retirement, carefully consider everything that you include.
This is particularly relevant if you’d like to retire extremely early (like in your 30’s and 40’s) through financial independence – which is known as FIRE.
The lower the cost of your future lifestyle, the faster you’ll be able to start living it.
How Much Does Your Lifestyle Cost?
Got an idea of how you want your retirement to look? Good, now it’s time to calculate the cost of sustaining that lifestyle.
The most accurate way of estimating your future cost of living is to know your current expenses.
Unless you’re planning to travel, move to a new house, or make any other significant changes, you’ll still have many of the same financial obligations.
So, gather information on all your outgoings and add up all the living costs that you’ll still have in retirement. Exclude any expenses you’ll no longer have, such as work travel, lunches, and uniforms.
And don’t forget to include any new costs you’ll have if you plan to start new hobbies, dine out more, or take more overseas holidays.
I would suggest creating a simple spreadsheet to work out the annual cost of your retirement:
Don’t forget to account for tax; use this calculator to work out the annual pre-tax income you’ll need.
In this example, we require a gross annual salary of £23,000 to net £19,280.
How Much Money Do You Need To Save For Early Retirement in the UK?
To fund your retirement, you’ll need to build a portfolio of income-producing assets that pay a regular, passive income.
You also have to maintain the purchasing power of your income by ensuring it’s growing at a rate that at least matches inflation.
And ideally, you also want the value of your portfolio to be rising faster than inflation so that you’re becoming wealthier.
The safest way of achieving safety of capital and income is through a portfolio of stocks and bonds.
There has been extensive research on the likely return and safe withdrawal rates (SWR) of such a portfolio, which gives us confidence that our investments are going to continue working for us when we no longer are.
If you’re not familiar with safe withdrawal rates, it is the maximum amount that you could withdraw from your pot each year without running out of money in your lifetime.
There have been many studies into the SWR, most notably by Wade Pfau. His research, which is summed up in the table below, shows that a portfolio of 50% stocks and 50% bonds never failed (i.e. ran out of money) in any 30-year period from 1926 to 2010, with a maximum SWR of 4%.
In layman’s terms, that means we can safely spend a maximum of 4% of the value of our portfolio each year.
Sounds good, but how big a pot of investments do we need?
With a little math (below), we can calculate that we need to save 25 x our annual spending to use a 4% SWR.
100% of your portfolio ÷ 4% safe withdrawal rate = 25
Using an annual pre-tax income of £23,000 from our above example, we require savings of £575,000 (held in 50% stocks and 50% bonds) to retire early.
It’s a large pot to save for sure, but it’s not insurmountable.
By making a few lifestyle changes to reduce living costs, you can save 50% or more of your take-home pay, even on a modest salary.
And with the snowballing effect of capital growth and compound interest working in your favour, you’ll find that it may take you as little as 5-15 years until you’re ready to retire.
Confidence In The 4% Rule
But what if I go broke in my golden years? What about inflation? This model is too simple!!!
The 4% rule is not without its haters. And they have a point… Historic cycles are in no way guaranteed to repeat themselves.
Our economy may experience a depression the likes of which we’ve never seen before, or we could be entering into a period of hyperinflation.
No one can predict what will happen with the global economy over the multiple decades we will be retired.
Yet, basing our future investment performance on the past is the most accurate method we have of estimating how well our investments are going to fare.
Although not guaranteed, history does tend to play out again and again and again.
Plus, the SWR studies also don’t include any other potential sources of income in retirement, such as state pensions, inheritance or part-time work.
And they don’t take into consideration that you may lower your spending during tough times, or that you’ll spend less as you get older (which is typical).
Taking everything into consideration, I’m still confident using a safe withdrawal rate of 4% for my retirement planning.
But if you don’t feel as optimistic about our economy’s future, using a SWR of 3% would be a more cautious approach.
Wrapping It Up
Traditional retirement is becoming less and less appealing.
I mean, who wants to wait until they’re old and grey to start living their best life (especially when there’s no need to)?
Early retirement is not a pipedream. It’s not up to luck, and it’s not reserved for the super-rich.
Saving the money required for financial independence in a few short years is more than possible, provided you have the discipline to save hard, and you’re willing to move away from a consumerist lifestyle.
Pedro is passionate about finance, marketing, and technology. He is a growth manager at several online projects and a former digital marketer for a fintech company.
